What is a lapping scheme?
– A lapping scheme is an accounts-receivable fraud in which an employee who handles cash receipts repeatedly misapplies customer payments to conceal the theft of cash. The thief uses a subsequent customer’s payment to “cover” the shortfall created when an earlier payment was stolen, then uses a later payment to cover that shortfall, and so on.
– Lapping temporarily masks the missing cash on the books by shifting payments among customer accounts, but the discrepancy eventually surfaces in the aging of receivables or during independent reconciliation.
How lapping works — simple numeric example
1. Customer A owes $150 and mails payment. Employee steals the $150 instead of applying it to A’s account.
2. Customer B sends $200. The employee applies B’s $200 to Customer A’s account (covering A). There is now $50 left of B’s expected payment that remains unrecorded for B.
3. Customer C sends $120. The employee applies C’s $120 to B’s account, leaving $70 of B’s original $200 still missing, and so on.
– Over time this creates a chain of misplaced payments. As long as the employee continuously intercepts subsequent payments, the fraud can remain hidden. If the chain is broken (e.g., a customer pays by an alternative channel), the shortfall shows up.
Why lapping happens and where it’s likely
– Lapping most commonly occurs where one person controls multiple cash/receivables duties (collecting cash, recording receipts, posting to customer accounts, preparing deposits).
– It is more likely in smaller businesses or poorly controlled functions in larger organizations where segregation of duties and independent reviews are weak.
– Perpetrators rely on being the daily link in accounting processes, which is why an unusual refusal to take vacations is a common red flag.
Common indicators and red flags
– Unexplained increases in the aging of accounts receivable, or sudden growth in past-due balances.
– Frequent manual adjustments to customer accounts or frequent “out of balance” correcting entries.
– Receipts posted after deposit dates, or differences between remittance advices and deposit slips.
– A single employee handling cash receipts, posting receipts, preparing deposits, and reconciling accounts.
– Employee refusal or inability to take vacation or to have another employee cover duties.
– Complaints from customers that their payments are uncredited or credited late.
– Unusual patterns in customer account balances (e.g., repetitive shifting or payments applied to wrong accounts).
How to detect lapping — practical audit and review procedures
1. Trace cash receipts end-to-end:
• Match remittance advices, checks, or electronic payment confirmations to entries in the cash receipts journal and to bank deposit slips and bank statements.
• Confirm that deposit dates precede or match posting dates to customer accounts (receipts should generally be posted promptly).
2. Perform surprise reconciliations:
• Surprise bank reconciliations and cash count / deposit verification by someone independent of receipts processing.
3. Review aging and account activity:
• Compare aging of receivables over time for unusual spikes; focus on accounts that are continuously kept current only by subsequent payments.
4. Analyze posting patterns:
• Flag receipts posted to customer accounts by someone other than the expected staffer or those with multiple manual adjustments.
5. Customer confirmations:
• Send confirmations to customers asking for outstanding balances and reconcile responses to the general ledger.
6. Forensic data analytics:
• Use data analytics to find sequences where payment dates and posting dates don’t line up (e.g., payments posted after later payments were applied).
7. Interview and review personnel behavior:
• Note employees who decline vacation time or are always the only person assigned to the receipts function.
Practical steps to prevent lapping — internal controls and process improvements
Administrative controls
– Segregation of duties: Separate receipt collection, posting to customer accounts, deposit preparation, and bank reconciliation among different people.
– Mandatory rotation and vacations: Require employees who handle cash or receivables to take periodic, uninterrupted vacations and make sure others perform their duties during that time.
– Dual controls for cash handling: Require two-person control for opening mail that contains payments and for preparing deposits.
Process and systems changes
– Lockbox or third-party processing: Use a bank lockbox for customer payments so payments are received and deposited by the bank, reducing employee access to cash and paper checks.
– Electronic payments: Encourage ACH, wire transfers, or credit-card payments that post directly to bank statements and can be reconciled automatically.
– Timely posting and reconciliation: Post payments daily and reconcile bank deposits to cash-receipts journals daily or weekly by someone independent.
– Automated remittance matching: Use accounting systems that automatically match remittance advices or electronic payment identifiers to customer accounts.
Monitoring and oversight
– Independent reconciliations: Have an independent person perform bank reconciliations and review aged receivables periodically.
– Surprise audits: Conduct periodic unannounced audits of receivables, deposits, and cash handling procedures.
– Supervisor review of adjustments: Require supervisory approval for write-offs, adjustments, credits, or manual reapplications to customer accounts.
– Access controls and logging: Restrict system access and maintain logs of who posts receipts and performs adjustments; periodically review logs for unusual activity.
People and culture
– Background checks: Perform pre-employment screening for employees who will handle cash.
– Fraud awareness training: Train staff and managers to recognize signs of fraud and to report suspicious activity confidentially.
If you suspect lapping — investigation and immediate actions
1. Preserve evidence:
• Secure accounting records, bank statements, deposit slips, remittance advices, emails, and system logs. Restrict the suspected employee’s access to records.
2. Conduct a forensic trace:
• Reconcile cash receipts receipts to bank deposits for the relevant period; trace individual customer payments through the receipts journal, system postings, and bank deposits.
3. Interview and document:
• Interview the involved employee(s) and relevant witnesses. Document all steps and findings.
4. Notify appropriate authorities:
• For serious theft, notify senior management, legal counsel, and, if warranted, law enforcement and insurers.
5. Remediation:
• Correct customer account balances and record losses. Recover funds where possible. Implement stronger controls and disciplinary measures.
6. Record and report:
• Adjust financial statements for any misstatements; disclose material fraud per accounting and regulatory requirements.
Sample control checklist to reduce lapping risk (practical quick list)
– Separate mail opening and cash posting duties.
– Use bank lockbox or direct payment channels.
– Require two-person handling for deposits.
– Post receipts daily; reconcile postings to deposits.
– Independent bank reconciliation (weekly/monthly).
– Mandatory vacations and rotation of personnel in the receipts function.
– Supervisory review and approval for adjustments.
– Regular analysis of AR aging and exception reporting.
– Access controls and audit trails in accounting systems.
– Periodic surprise audits and customer confirmations.
Why lapping eventually fails
– Lapping depends on an unbroken sequence of incoming payments and the lapping employee remaining the only person with the ability to reallocate receipts. If a customer pays outside the pattern, if the employee is absent, or if independent reconciliations occur, the missing funds are exposed. Aging receivables get older, and the chain collapses, forcing the company to recognize the loss.
Importance for small businesses
– Small firms with limited accounting staff are particularly vulnerable. Implementing even simple controls (mandatory vacations, separate duties when possible, use of lockbox or immediate electronic payment acceptance, periodic independent account reviews) materially reduces risk.
Conclusion
Lapping is a classic receivables fraud that can persist for some time if internal controls are weak and one person controls multiple steps of the cash-receipts process. Timely detection depends on tracing receipts from customer remittances to bank deposits and regularly reviewing receivable aging, while prevention centers on segregation of duties, independent reconciliations, lockbox/electronic payments, and supervisory oversight.
Sources and further reading
– Investopedia — “Lapping Scheme” (provided source):
– Association of Certified Fraud Examiners (ACFE) — fraud scheme descriptions and Report to the Nations (for general prevalence and controls)
– COSO — Internal Control — Integrated Framework (for control design principles)
– Provide a step-by-step audit worksheet you can use to test for lapping in your AR process.
– Convert the prevention checklist into an implementation plan with owners and timelines.